Friday, August 10, 2007

Another Look at Delaying Starting Social Security Benefits One Year

In an earlier post, I compared the added monthly Social Security benefit received for delaying starting your benefits against the monthly annuity payment that could be purchased with the amount of benefits "lost" by waiting. The comparison used inflation-adjusted annuities, since Social Security is also indexed for inflation.

In this post I'll compare delaying Social Security benefits against a withdrawal rate from your own retirement savings based on the 4% rule-of-thumb.

Under the 4% rule-of-thumb for retirement withdrawals, you take out 4% of your savings in the first year you retire. The second year you take out an increased amount based on inflation, and continue to adjust your withdrawals each year after that for inflation. For example, with retirement savings of $250,000, you take out $10,000 the first year and if inflation is 3% you take out $10,300 the second year, $10,609 the third year, and so on.

Let's consider an example of a Boomer born before 1955 with a monthly Social Security benefit of $1000 at his Normal Retirement Age of 66. If he waits one year before starting his Social Security, then his benefit would be 8% higher or $1080/month. During that year's delay, he "gave up" $12,000 of Social Security benefits, but gets an additional $960/year thereafter. During the year of delay, he had to make up the $12,000 by extra withdrawals from his retirement savings. At age 67 when starting Social Security, he recalculates his withdrawals from his retirement savings using the 4% rule-of-thumb and finds that he needs to reduce withdrawals by 4% of the $12,000 or $480/year.

So what's the net change in annual income for our example Boomer from delaying Social Security?
+ $960 from Social Security
- $480 from retirement savings
+ $480 net annual increase.

In addition, depending on his taxable income (which include withdrawals from tax-deferred retirement savings), he could find his taxable income reduced by up to $480.

Who loses by his doing this? His heirs, should he die early -- if he died at age 67 then his heirs would inherit $12,000 less. IMO, this should not be a consideration unless your heir is your dependent, such as a special needs child. Otherwise, it's better that you have a secure retirement and not depend on your heirs for support.

In a future post, I'll discuss the 4% rule-of-thumb and my take on it.


J at IHB and HFF said...

Hello. Your blog is one of those with good content that should get more attention/activity. I was going to do an article similar to yours here but instead I will make suggestions since you have the head start. A chart or table would help to see the delay/don't decisions. It would be nice to see numbers from 62-70 and various work income (before or after retirement) instead of annuity income--if you happen to have too much free time right now.

EMF (Engineer) said...

Thanks for the positive comments on my blog.

I do plan to add more charts to my blog, now that I've figured out how to manipulate Blogspot into showing them.

I'm not sure that I understand your last sentence though. I'll offer my perspective, based somewhat on a guess as to what you're after.

I think that retirement planning should be based on what your spending during retirement will be, rather than your income. As the average person approaches retirement, income tends to increase as his career matures. At the same time expenses tend to decrease: kids grow up and get on their own, the house is paid off. So this is the time that many people try to catch up on retirement savings. Including me, though I have done some retirement savings all along, at least getting the employer match in my 401k. Right now, though, I'm living well beneath my means so I can maximize tax-advantaged retirement savings. And I'm estimating my retirement based on current spending, though health care cost is a big wild card.

Social Security benefits are based more on lifetime earnings, rather than on the last few years as are some pension plans.

Don't know if this changes your question. But if you give some more information and I think it may pertain either to me or to quite a few others, I might model it in a spreadsheet and write a post on it (with a graph).